The ability to identify changes in activity costs as activity output changes allows managers to more carefully plan and monitor activity improvements. Activity flexible budgeting is the prediction of what activity costs will be as activity output changes. Variance analysis within an activity framework makes it possible to improve traditional budgetary performance reporting. It also enhances the ability to manage activities.
In a functional-based approach, budgeted costs for the actual level of activity are obtained by assuming that a single unit-based driver (units of product or direct labor hours) drives all costs. A cost formula is developed for each cost item as a function of units produced or direct labor hours. Exhibit 12-6 presents a functional-based flexible budget based on direct labor hours. If, however, costs vary with respect to more than one driver and the drivers are not highly correlated with direct labor hours, then the predicted costs can be misleading.
In a functional-based approach, budgeted costs for the actual level of activity are obtained by assuming that a single unit-based driver (units of product or direct labor hours) drives all costs. A cost formula is developed for each cost item as a function of units produced or direct labor hours. Exhibit 12-6 presents a functional-based flexible budget based on direct labor hours. If, however, costs vary with respect to more than one driver and the drivers are not highly correlated with direct labor hours, then the predicted costs can be misleading.
The solution, of course, is to build flexible budget formulas for more than one driver. Cost estimation procedures (high-low method, the method of least squares, and so on) can be used to estimate and validate the cost formulas for each activity. In principle, the variable cost component for each activity should correspond to resources acquired as needed (flexible resources), and the fixed cost component should correspond to resources acquired in advance of usage (committed resources). This multiple-formula approach allows managers to predict more accurately what costs should be for different levels of activity usage, as measured by the activity output measure. These costs can then be compared with the actual costs to help assess budgetary performance. Exhibit 12-7 illustrates an activity flexible budget. Notice that the budgeted amounts for direct materials and direct labor are the same as those reported in Exhibit 12-6; they use the same activity output measure. The budgeted amounts for the other items differ significantly from the traditional amounts because the activity output measures differ.
Assume that the first activity level for each driver in Exhibit 12-7 corresponds to the actual activity usage levels. Exhibit 12-8 compares the budgeted costs for the actual activity usage levels with the actual costs. One item is on target, and the other six items are mixed. The net outcome is a favorable variance of $21,500. The performance report in Exhibit 12-8 compares total budgeted costs for the actual level of activity with the total actual costs for each activity. It is also possible to compare the actual fixed activity costs with the budgeted fixed activity costs, and the actual variable activity costs with the budgeted variable costs. For example, assume that the actual fixed inspection costs are $82,000 (due to a midyear salary adjustment, reflecting a more favorable union agreement than anticipated) and that the actual variable inspection costs are $43,500.
Assume that the first activity level for each driver in Exhibit 12-7 corresponds to the actual activity usage levels. Exhibit 12-8 compares the budgeted costs for the actual activity usage levels with the actual costs. One item is on target, and the other six items are mixed. The net outcome is a favorable variance of $21,500. The performance report in Exhibit 12-8 compares total budgeted costs for the actual level of activity with the total actual costs for each activity. It is also possible to compare the actual fixed activity costs with the budgeted fixed activity costs, and the actual variable activity costs with the budgeted variable costs. For example, assume that the actual fixed inspection costs are $82,000 (due to a midyear salary adjustment, reflecting a more favorable union agreement than anticipated) and that the actual variable inspection costs are $43,500.
Breaking each variance into fixed and variable components provides more insight into the source of the variation in planned and actual expenditures. Activity budgets also provide valuable information about capacity usage.
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